Advanced Energy Industries, Inc.

to abate and are no longer a significant constraint on revenue. There are still components with very long lead times, such as power MOSFETs, but we think that supply will catch up with demand in the coming months. Now I'll provide further color on each of our markets. In semiconductor, third quarter revenue increased sequentially to $185 million. we saw increased demand for RF products used in etch and deposition applications. In addition, we achieved record revenue for our high voltage products, which are used primarily in ion implanters. Service revenue decreased sequentially due to lower fab utilization. For the year 2023, however, we expect to set a service revenue record based on our larger installed base and a richer menu of value added services. We continue to work closely with our key customers to design in our next generation Everest and EVOS platforms. We have received numerous orders for these recently launched platforms and are working hard to satisfy the near term demands of our customers. We believe that Everest and EVOS will enable our customers to more effectively overcome the technical challenges of substitute nanometer processes. These new technology platforms have the potential to drive meaningful revenue growth for many years to come. Moving to industrial and medical. Third quarter revenue was $115 million, down sequentially following several record quarters. Revenue came in slightly below our plan due primarily to softer market conditions late in the quarter. We launched five new products into the industrial medical market, including the IHP liquid, a fully sealed, liquid-cooled power supply designed to operate in harsh manufacturing environments. In the industrial market, we secured notable design wins across robotics, factory automation, and thin-fill manufacturing application. Our medical design and activity was particularly strong in the third quarter, with significant wins in diagnostic and therapeutic application. In August, we launched the new Advanced Energy website. Creating the content for this website was a company-wide effort, and we are pleased with the quality and ease of use of our new site. We expect the new website will enable us to reach a much wider cross-section of industrial and medical customers. In early 2024, we will add e-commerce capability to the website, providing another way for our customers to order and rapidly evaluate our product. Overall, we believe that our DesignWin pipeline and improved go-to-market strategy should partially offset the potential impact of macroeconomic company. In data center computing, their quarter revenue increased sequentially to $68 million, as expected. Strong revenue from the ramp of a hyperscale design win for AI applications offset lower sales to enterprise customers. Telecom and networking revenue decreased sequentially to $41 million, in line with our expectations. Now let me share a few closing thoughts. At the beginning of 2023, we expected that semiconductor revenues would be down year on year and that the rest of our business would be flat to up. We also said that our semiconductor business would trough in the second quarter, largely how things have played out in 2023, despite a softer macroeconomic environment in the second half of the year. Looking forward, we will continue to move full speed ahead executing the strategy we first articulated two years ago. New products and technologies, a more aggressive go-to-market strategy, and improved manufacturing efficiency will remain our primary areas of focus. With our recently completed convertible node offering, we have secured low-cost financing, which can potentially accelerate our growth. We continue to look for M&A opportunities which makes strategic and financial sense for the company. Leveraging a broad offering of highly differentiated products, a record number of design wins, improved manufacturing efficiency, and a strong balance sheet, we believe that Advanced Energy is well positioned to grow faster than our markets. Paul will now provide detailed financial information.

Thank you, Steve, and good afternoon, everyone. Q3 was a quarter of solid execution with earnings that came in at the high end of our guidance on slightly lower revenue. We saw some demand softening late in the quarter, largely due to macroeconomic factors. However, actions we took to improve our operations and control discretionary spending enabled us to deliver sequentially higher gross and operating margins. Together with higher interest income and lower taxes, earnings increased 16% sequentially on 1% lower revenue. Importantly, operating cash flow was at the highest level ever for the company. Finally, with shortened lead times, customers are adjusting their order patterns and our backlog came down to $514 million. We continue to expect our backlog will settle to a level of $400 to $500 million by the end of the current quarter. Overall, Despite a softer demand environment, we believe the year is shaping up as we had expected. We are focused on driving new product activity and improving our cost structure while preparing for the next upturn. Now let's review our financial results in more detail. Total revenue was $410 million, down 1% sequentially and 21% from our peak quarter a year ago. Revenue in the semiconductor market was $185 million, up 7% quarter over quarter, consistent with our view that Q2 was a near-term bottom. Revenue in the industrial and medical market was $115 million, down 10% from last quarter and 4% year over year. Following several quarters of record results, industrial and medical saw some softening in demand late in the quarter. Looking forward, we expect incremental revenues from prior design wins to largely offset the impact of a sluggish macroeconomic environment in Q4. Data center computing revenue is up 16% sequentially to $68 million due to the ramp of a hyperscale customer for AI applications. Sales declined 22% year over year due to the cyclical downturn in the enterprise server market. Telecom and networking revenue at $41 million was down 26% sequentially and 3% year-over-year, as we fulfilled overdue backlog. Q3 gross margin was 36.1%, up 50 basis points from Q2 on lower volume, as we benefited from improved mix and lower material costs. Premiums we paid for critical components continued to taper, as costs from prior quarters rolled through inventory to the P&L we expect to see the full benefits of lower premiums in the first half of 2024. We also continue to take actions to optimize our operations footprint and manufacturing efficiency. Consolidating capacity into larger, more efficient factories should contribute to higher gross margins over the course of 2024. Operating expenses were $97.3 million down from last quarter. OpEx was below our guidance as we managed our cost structure and controlled discretionary spending. Q3 operating margin was 12.4%, up 50 basis points sequentially. Depreciation was $9.7 million, and our adjusted EBITDA was $61 million. Non-GAAP other income was $1.3 million due to higher net interest income partially offset by foreign exchange losses. Looking forward, We expect our non-GAAP other income to be in the range of $3 to $3.5 million for the next few quarters, given our level of cash and current interest rates. As a reminder, in the fourth quarter of 2022, we initiated a restructuring plan to optimize our manufacturing operations. We are on track to our plan and expect to see the benefits of our action translating to better margins over the course of 2024. Consistent with this plan, we recognized $5 million in restructuring costs in Q3 and expect to incur an additional $5 to $8 million in the fourth quarter. Our non-GAAP tax rate was 7.2 percent, below our Q3 target of 17 percent due to discrete benefits related to tax strategies we implemented this quarter to lower our tax rate. As a result of these strategies, We are now modeling our Q4 and 2024 GAAP and non-GAAP tax rate at around 16%. Third quarter EPS of $1.28 was at the high end of our guidance of $1.13 and above Q2 of $1.11, but down from $2.12 a year ago. If you apply our prior target tax rate of 17%, Q3 EPS would have been $1.15. Turning now to the balance sheet. Total cash and marketable securities at the end of the third quarter were $986 million and included approximately $482 million in net proceeds from transactions associated with our 2.5% convertible senior notes offering that we completed in September. Operating cash flow from continuing operations was a record $72.7 million. Excluding the convertible offering and related transactions, cash increased from $455 million to $504 million. Net cash at the end of the third quarter was $66 million. Inventory decreased $28 million, down 7% sequentially and 11% year-over-year, as actions to monetize on-hand inventory started to contribute to cash flow. As a result, inventory days decreased from 132 in Q2 to 125 in Q3, and turns improved from 2.7 to 2.9 times. Days payable decreased two days sequentially to 48 days, and DSO increased three days to 59 days. Networking capital was 136 days. CapEx was $13 million, or 3.2% of sales, and below our near-term target of approximately 4%. We continue to expect our CapEx for this quarter and the next year to remain around 4% of sales, which includes the cost of our manufacturing consolidation plan and the investment in the new Thailand factory. During the quarter, we made debt principal payments of $5 million and paid $3.8 million in dividends. Finally, as part of the convertible note offering, we used $40 million to purchase 370,000 shares of our common stock. Now let's turn to our guidance. Consistent with our commentary from last quarter, we expect that second-half semiconductor revenue will be flat to up versus the first half. For our non-semiconductor markets in aggregate, we continue to expect 2023 revenue to grow slightly from last year, with low double-digit growth in industrial and medical and telecom and networking, offset by cyclical weakness in data centers. However, looking forward, we expect telecom and networking revenues to continue to normalize towards $30 million a quarter over the next couple of quarters. As a result, we are forecasting our Q4 revenue at $405 million, plus or minus $15 million. We expect Q4 gross margin to be similar to Q3 on slightly lower volume. We expect Q4 operating expenses be about flat with Q3 with timing of investments and new products offset by other cost reduction. Based on a tax rate of 16%, we expect Q4 non-GAAP earnings per share to be $1.15 plus or minus 20 cents. Let me make a few concluding comments. Overall, we are executing our plans for 2023. Our diversification strategy is enabling us to mitigate the impact of a sluggish macroeconomic environment and ongoing corrections in some of our markets. We continue to expect to perform better than in our markets and significantly better than in previous semiconductor cycles. Looking forward to 2024, we expect semiconductor revenues to continue to bounce around these levels for the next few quarters, but are prepared for upside if the market recovers sooner. We expect performance in our other markets to be paced by macroeconomic factors, timing of customer orders and hyperscale, and normalization of revenue levels in telecom and networking, all partially offset by opportunities for growth from new products and channel investments. In the meantime, we are focused on improving gross and operating margins while investing in critical programs to prepare for the next cyclical upturn. We believe our actions to control costs improve operational efficiency, and shift mix towards higher margin products position the company to reach our long-term gross margin target of over 40%. Finally, with solid operating cash flow and a strong cash position, we have financial flexibility and multiple paths to create value for our shareholders. With that, let's take your questions.

Operator? Thank you. At this time, we'll be conducting a question and answer session. If you'd like to ask a question, please press star 1 on your telephone keypad and a confirmation tone will indicate your line is in the question queue. You may press star 2 if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Thank you, and our first question today comes from the line of Jim Rusciutti with Needham & Company. Please proceed with your question.